Bernanke On Regulation

Fed Chairman Bernanke delivered a speech to the Council on Foreign relations. In it he touched on “too big to fail”, the causes of the current financial crisis and possible future regulatory steps.

“…Like water seeking its level, saving flowed from where it was abundant to where it was deficient, with the result that the United States and some other advanced countries experienced large capital inflows for more than a decade, even as real long-term interest rates remained low.

The global imbalances were the joint responsibility of the United States and our trading partners, and although the topic was a perennial one at international conferences, we collectively did not do enough to reduce those imbalances. However, the responsibility to use the resulting capital inflows effectively fell primarily on the receiving countries, particularly the United States. The details of the story are complex, but, broadly speaking, the risk-management systems of the private sector and government oversight of the financial sector in the United States and some other industrial countries failed to ensure that the inrush of capital was prudently invested, a failure that has led to a powerful reversal in investor sentiment and a seizing up of credit markets. In certain respects, our experience parallels that of some emerging-market countries in the 1990s, whose financial sectors and regulatory regimes likewise proved inadequate for efficiently investing large inflows of saving from abroad. When those failures became evident, investors lost confidence and crises ensued. A clear and highly consequential difference, however, is that the crises of the 1990s were regional, whereas the current crisis has become global.“

I suppose there is an element of mea culpa somewhere in that statement. Admittedly you have to dig deeply to find it but at least he admits to a systemic failure to do the appropriate things.

Mr. Bernanke uses the introduction of the causes of the crisis as his launch pad for a discussion of regulatory reform. He begins by pointing out the evils of a system in which the concept of too big to fail exists and then admits that there are some financial institutions that fit that bill.

In the midst of this crisis, given the highly fragile state of financial markets and the global economy, government assistance to avoid the failures of major financial institutions has been necessary to avoid a further serious destabilization of the financial system, and our commitment to avoiding such a failure remains firm. Looking to the future, however, it is imperative that policymakers address this issue by better supervising systemically critical firms to prevent excessive risk-taking and by strengthening the resilience of the financial system to minimize the consequences when a large firm must be unwound.

Note that here as well as elsewhere in the speech there is no mention of reducing the size of major financial institutions. The discussion is broad, wonkish and decidedly lacking in specifics. He touches on the need for some sort of regulatory regime for institutions that assume significant financial risk — think AIG and GE — and then talks a great deal about this or that proposal and what we need to do, but how we need to proceed carefully, blah, blah, blah. You know the drill. I believe he also sets a world record for the use of the word systemic or some derivation of it.

Towards the end of the speech, he touches on the subject of who should be the primary regulator. Naturally, he thinks that the only body with the brains to do it is the Fed but he can’t say that, so he talks like a reluctant virgin that protests weakly as she moves with all deliberate speed towards the bed.

All in all, there isn’t a lot new in here. You can try and read the tea leaves to get a sense of where he wants to go with regulation but in the end it isn’t his call. Better, I think, to listen to Barney Frank, Chris Dodd and their cohorts on Capitol Hill. I know that isn’t a pleasant prospect but it is reality.